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The Gold Cycle Has Bottomed

There is no denying that
the gold market has been on the most tortuous ride lately. Just as bulls think
the correction is over and start to build new long positions, the markets
slices through $1400 and drops to just below $1200. Even some of the most
ardent bulls are now referring to gold as “insurance” instead of an
“investment”. Gold is one of the most hated asset classes at the moment.
This is all part of the bull market process, throwing off as
many investors as possible before the finale. It happened with the dotcom bull
market in 1997/98 and bonds in 2008/9 and it is now happening with gold.

Peter Schiff of Euro Pacific Capital summed up this nicely
in an article for Zerohedge.com:

“The New York Times had the definitive take on the vicious
sell off in gold. To summarize one of their articles:

Two years ago gold bugs ran wild as the price of gold rose
nearly six times. But since cresting two years ago it has steadily declined,
almost by half, putting the gold bugs in flight. The most recent advisory from
a leading Wall Street firm suggests that the price will continue to drift
downward, and may ultimately settle 40% below current levels.

The rout says a lot about consumer confidence in the
worldwide recovery. The sharply reduced rates of inflation combined with
resurgence of other, more economically productive investments, such as stocks,
real estate, and bank savings have combined to eliminate gold's allure.

Although the American economy has reduced its rapid rate of
recovery, it is still on a firm expansionary course. The fear that dominated
two years ago has largely vanished, replaced by a recovery that has turned the
gold speculators' dreams into a nightmare.

This analysis provides a good representation of the current
conventional wisdom. The only twist here is that the article from which this
summary is derived appeared in the August 29, 1976 edition of The New York
Times. At that time gold was preparing to embark on an historic rally that
would push it up more than 700% a little over three years later. Is it possible
that the history is about to repeat itself?”

While we all know that past performance is no guarantee of
future returns, history is a very useful guide when creating a strategy to
position ourselves as the investment cycle unfolds.

The run up in the gold price leading to September 2011 did
appear to be bubble like, but the lack of widespread participation in gold is
inconsistent with a long term top being in. I’d like to see adverts in the
weekend newspapers selling gold as a long term investment to retail investors
and mainstream journalists advocating the case for gold (think of Apple’s
massively oversubscribed bond sale in April 2013). I think this phase of the
gold bull market lies ahead of us and I am about to tell you why.

I am not going to lie, this cyclical bear market in gold has
caught me out, but it hasn’t been completely unexpected. As we have just read,
Gold halved between 1974 and 1976 and whilst I didn’t expect this to happen
(and saw no reason why it should), I had it in the back of my mind that it
might.

Readers of my book will know about The 17.6 Year Stock
Market Cycle and be familiar with the associated commodity cycle that is
briefly mentioned. Using this cycle I have forecast a secular 17.6 year gold
bull market top in 2015. However there is also an interesting 1.76 year
sub-cycle that can help us when trying to forecast future turning point.

It is important to note that the dates of these turning
points are not the date of the exact top/bottom but are reasonably accurate as
the table above, and chart below, shows. Also note how some of the tops were
quickly passed again at the beginning of the bull market and didn’t result in
significant pullbacks.

Needless to say I wasn’t caught holding long positions in
2011, but you can see why I bought in mid 2012 in anticipation of the next
rally, which didn’t lead to new highs as expected. I have labeled June 2013 as a
bottom because it obviously isn’t a top, but we’ll have to wait and see if that
is correct.

If we look back at the last secular 17.6 year gold bull
market we can see a similar pattern. If we take away 17.6 years from the start
of the last bull market, May 1999 using the cycle dates above, that takes us to
January 1980. This was indeed the blow off top for the last gold bull market,
although the preceding turning points can be a few months off [note the World
Gold Council only had data going back to 1970, but the price was fixed at $35
an ounce from 1944 to 1971]:

Although the exact timing of a turn is unpredictable, and we
are not even sure if the turning points are tops or bottoms, the nature of the
sell off preceding this most recent turning point indicates that it is a
bottom. However the fact that we are approaching the end of the 17.6 year
secular cycle gives me confidence that the blow off top for this secular bull
market is ahead off us in 2015 and that is why I have not sold any of my gold
during this sell off.

About Kerry Balenthiran

Kerry Balenthiran studied mathematics at the University of Warwick and then worked as a Spacecraft Operations Engineer in the UK and at the European Space Agency. He qualified as a chartered accountant with Arthur Andersen and now works as a consultant within financial services. His mathematical background led to a fascination with the cyclical nature of stock market booms and busts.

How do we know where we are in the current stock market cycle?

Are we in the midst of a new long term bull market or a market rally within an ongoing bear market?